Choose Your Own Adventure | September 2024
Over the past five years, the bond market story has read like a choose-your-own-adventure novel, jumping from one plot line to another.? We had the emergency response to the pandemic, followed shortly thereafter by aggressive rate hikes in the fight against inflation.
Once again, the page has flipped to a new storyline: the rate-cutting cycle.? With the Fed bringing a ‘jumbo’ cut to the party, the latest adventure is officially underway.
Skipping ahead:
Most authors will have readers stop at each central bank meeting to make a choice: 25 bps, 50bps, or pause.? We find that too long and tedious and prefer to skip to the end of this act.
After all, we all know the direction this story is taking.? The real question is, where does this journey end?
The consensus plotline:
The wisdom of the crowd (i.e., futures pricing and yield curves) sees this storyline ending next year with policy rates of 2.5%- 2.75% in Canada and 2.75%- 3% in the US.? Based on their latest dot plot (September), the Fed agrees with the market’s endpoint but forecasts a slower pace to get there.
If you disagree with the consensus and think cuts will be deeper, proceed to the next section.? If, instead, you believe the central banks will stop higher, skip ahead to ‘they stop higher’.
They go lower:
‘Ouch’, you have landed in a dark (hard) place. ?A world of high unemployment and negative growth has forced central bankers to drop rates to around 1% to stimulate the economy.
They stop higher:
In this scenario, the economy is resilient, and unemployment is contained, allowing central bankers to stop cutting rates.? After all, why would they cut more than they have to?? Maintaining a higher policy rate gives them room to respond should a crisis emerge later in the story.
The bottom line:
Ultimately, how this story unfolds is still too uncertain to predict. ?But there are two things we can be sure of: there will be plot twists, and overnight rates will be lower a year from now.
Sadly, for King Cash and his royal court of GICs and discount bonds, this means an abrupt end to their reign. ?With yields on these instruments steadily falling, investors are fleeing their kingdom in search of better returns.
The next act:
Where investors rotate their cash will depend on their objectives. ?As always, we are happy to discuss suitable ideas based on your and your client’s needs.
Lastly, for those readers curious about what happens after the cuts are done, flip to next month’s commentary.